Will you choose litigation or arbitration to settle disputes?

Brian Moran

Mon, 2011-10-10 07:32

The choice of arbitration or litigation is one of the most important business decisions you can make. It's also a decision typically ignored by small businesses until it's too late. You might think that arbitration and litigation is pretty a boring topic. I get that. But keep reading. Today’s post is powerful advice based on personal experience. I was 15 years into my business career before I had any sense of how important the topic really is. Hopefully I can save you a few scars. Every small business owner and anyone who aspires to be one someday should think through this topic.

You’ve heard the statistics that talk about the very high percentage of marriages that end in divorce, right? Well guess what? The same applies in business. Most newlyweds say ”that will never happen to us” and so do most business partners. Marriage is supposed to last until death do us part. All businesses will have disputes. Guess what. The best time to agree on how to solve a dispute is when the people involved still like each other and aren’t arguing over something.

Ever seen a TV show where the crime is committed, the investigators investigate, and the outcome of a trial is decided in 40 minutes with 20 minutes of fast-forwarded commercials? Real court room drama takes much longer and civil litigation is no exception. We like to imagine the scales of Lady Justice being swift and blind. I won’t comment on blind. Swift she is not. Simple lawsuits can easily take more than a year to resolve and it’s not uncommon for them to drag out for years. What about arbitration? A dispute that takes years to litigate might easily be resolved in weeks or months through arbitration. Lawsuits that cost $100,000 might be resolved through arbitration for $30,000 just to give you feel for what the differences might be) and in an abbreviated amount of time.

The cost and time implications of litigation mean that it’s very easy for one party in a civil dispute to abuse the process and for justice to not be carried out. Here is a simple example.

Let’s create a ridiculously simple hypothetical scenario:

Party A owes Party B $50,000

A written contract clearly defines the obligation between the two parties.

Party A refuses to pay the money for some reasons.

We use our crystal ball to know in advance that a jury of peers will eventually unanimously side with Party B if the matter goes to trial.

What happens? Party B gets their money? Slam dunk, right? Not so fast. Remember that it might take tens of thousands of dollars and a year or more to resolve even a pretty simple case. What if Party B needs to spend 50K in legal fees to collect the 50K and the process takes a year? Hmm. What does Party B do in that case? Party B probably gets angry and bitter, and they probably walk away from the 50K that is owed to them. It’s not rational to spend 50K to get 50K and to spend the time involved in the legal matter. Is it? You might be wondering whether or not Party B can recoup its legal fees when it wins. The rules vary from country to country but generally all parties eat their own legal fees in the USA.

Let’s change the amount and pretend that Party A owes Party B $200,000. Hmm. Party B might be willing to invest a year of their life to win 200K even if it costs 50K plus the time and emotional commitment of dealing with the lawsuit. 150K is a lot of money, right. No one wants to walk away from that. But what if Party B doesn’t have 50K in cash lying around to pay their attorneys and see the lawsuit through to the end? Hmm. Well in that case Party B most likely gets angry and bitter and eventually walks away not getting their money.

Twenty years of business experience and some compelling practical experience has taught me that small businesses should always prefer arbitration over litigation. Always? Yes. I’m cheating a bit when I say always since I say you should always “prefer” arbitration. What I’m really saying it’s best to always choose arbitration over litigation as your default unless you have a compelling reason to stick with litigation as a dispute resolution approach. Of course the exact opposite is what typically happens since most business owners ignore the decision entirely. ”Not choosing” essentially chooses litigation since arbitration only happens when all parties agree to it.

Why do I encourage you to proactively choose arbitration? Simple. Litigation is very expensive and can drag on for years and it’s very easy for one party to abuse the litigation process to “win” even when they are wrong.

Litigation is much more expensive than you may think. Unless you are representing yourself instead of hiring professional legal help, it’s almost impossible to sue anyone for anything in state or federal court in the United States for less than $20,000 for even incredibly simple matters. That number can quickly exceed $50,000 or $100,000. Do you think SQL Server performance tuning experts have high hourly bill rates? Hmph. Experienced litigation partners in a decent law firm will run you over $400/hour and their junior associates will generally be north of $250/hr. That adds up.

Ponder this follow up question to the scenario that we explored above. What if Party A knows that it truly owes the money but believes that Party B simply doesn’t have the funds to deal with litigation? What if they know that Party B does in fact have the money, but decide they would rather be forced to pay the money in a year or two rather than honor their contractual requirement now? Does that happen? Sure. Stuff like that happens all the time in business. To be fair, it might not be so egregious where Party A truly actually believes it owes the money and decides to litigate. But that happens a lot too.

Binding arbitration is invariably cheaper and faster than litigation. People will disagree in business matters from time to time. That’s inevitable even when everyone is acting honestly and in good faith. Arbitration tends to level the playing field and produce an answer that is appropriate in a reasonable time frame for a reasonable amount of money. Alas, the cost and timeframes of litigation often come to mean that Lady Justice is neither swift nor blind.

In the past, my most important business agreements defaulted to litigation since I wasn’t savvy enough to consider the alternatives. It’s caused me some pain but fortunately I’ve had the financial resources to defend my rights. Moving forward, my important business agreements will always choose arbitration over litigation unless there is an incredibly compelling reason to choose otherwise. Right now I can’t think of any reasons that qualify.

You don’t have to agree with my conclusions. But promise me that you will at least think through the matter and make an informed choice rather than ‘choose’ litigation by default.